Moody’s Bank Downgrades Risk Choking European Recovery

The BNP Paribas SA logo is seen outside the company's office in Paris. Even after the ECB provided an unprecedented 1 trillion euros of three-year loans to bolster the region’s banks, loans to non-financial companies in the euro area fell 0.17 percent in April, according to ECB data. Photographer: Balint Porneczi/Bloomberg

May 9 (Bloomberg) -- Moody’s Investors Service will this
month start cutting the credit ratings of more than 100 banks, a
move that risks pushing up their funding costs and forcing them
to curb lending in a threat to economic growth.

BNP Paribas SA, France’s biggest lender, Deutsche Bank AG,
Germany’s largest, and New York-based Morgan Stanley are among
firms that face having their short- and long-term debt
downgraded to their lowest-ever levels by Moody’s, the ratings
company said in February.

The cuts, which would follow downgrades by Standard &
Poor’s and Fitch Ratings last year, could erode profits, trigger
margin calls and leave some firms unable to borrow from money-market funds that have strict rules on who they can lend to.
Without access to funding from private sources, banks have had
to sell assets and reduce lending.

“I’d like to say the views of the rating agencies don’t
matter anymore but, unfortunately, they do,” said Philippe
Bodereau, London-based head of European credit research at
Pacific Investment Management Co., the world’s largest bond
investor. “This is a setback for the banks, particularly when
you consider how much progress they have made in making
themselves safer and more transparent.”

‘Intense Pressure’

Even after the European Central Bank provided an
unprecedented 1 trillion euros ($1.3 trillion) of three-year
loans to bolster the region’s banks, loans to non-financial
companies in the euro area fell 0.17 percent in April, according
to ECB data. Europe’s economy probably slipped into recession in
the first quarter as the debt crisis forced governments to step
up spending cuts, according to 16 out of 19 economists surveyed
by Bloomberg.

“The more the cost of wholesale funding goes up, the more
likely it is that banks will want to retreat closer to a loan-to-deposit ratio of one,” said Huw van Steenis, a banking
analyst at Morgan Stanley in London. “That adds to the intense
pressure to deleverage, which will be a drag anchor on European
economic recovery.”

Moody’s said in January it would overhaul how it rates
European banks and firms with global securities operations to
reflect the adverse effects of the sovereign-debt crisis,
dwindling economic growth and the latest round of capital rules
set by the Basel Committee on Banking Supervision.

The ratings company said in an April 13 note that it will
start the downgrades in early May with a review of Italian
lenders, before moving on to countries including Spain, Austria,
Sweden, Norway, the U.K. and Germany. Global capital-markets
firms, including the U.S. investment banks, are unlikely to have
their ratings changed until June, according to analysts.

‘Speculative Elements’

“The combination of current challenges and inherent risk
factors has introduced speculative elements into the obligations
of these firms that we believe are not fully reflected in their
current ratings,” Moody’s said in a note published Jan. 19.
Jessica Eddens, a spokeswoman for the firm, declined to comment
on the review.

UBS AG and Credit Suisse Group AG, Switzerland’s biggest
lenders, Spain’s Banco Bilbao Vizcaya Argentaria SA and Morgan
Stanley, owner of the world’s largest brokerage, are facing
three-step downgrades on their long-term debt, Moody’s said.
JPMorgan Chase & Co., the largest and most profitable U.S. bank,
Goldman Sachs Group Inc., the fifth-biggest in the U.S., and
HSBC Holdings Plc, the U.K.’s biggest, could be cut two levels.

Moody’s may apply less severe downgrades after a stronger-than-expected first quarter, Pimco’s Bodereau said. Officials at
the banks declined to comment.

Any ratings cuts would heap further misery on the industry
as the boost that followed the ECB’s cash injections in December
and February wears off and policy makers struggle to extinguish
the sovereign-debt crisis.

Bank Stocks

The 43-member Bloomberg Europe Banks and Financial Services
Index has fallen 19 percent from its March 19 high. The Markit
iTraxx Financial Index of credit-default swaps, which measures
the cost of insuring the debt of 25 European banks against
default, has jumped 47 percent over the same period. Bank stocks
led the Stoxx Europe 600 index almost 1 percent lower as of noon
in London trading today.

Bank of America Corp., the U.K.’s Barclays Plc and Royal
Bank of Scotland Group Plc, and UBS are among firms whose short-term debt ratings, for loans of less than a year’s duration,
could be cut. A reduction to P-2 from P-1 would bar some money
funds from providing them with loans. The banks declined to
comment about the ratings reviews.

U.S. money-market funds cut their exposure to lenders at
risk of being downgraded to P-2 by $21 billion in the two months
ended in March, according to an April 11 report by Alex Roever,
an analyst at JPMorgan in New York. The funds increased their
exposure to banks not under review by Moody’s by $4 billion.

Narrowing Funding Sources

“This scenario clearly narrows funding sources,” Kinner
Lakhani, a London-based analyst at Citigroup Inc., said in an
April 30 note to clients.

Downgrades also threaten to reduce banks’ access to longer-term funding. European banks’ earnings could be reduced by 2
percent to 6 percent, Lakhani wrote, because investors demand a
higher yield to lend to lower-rated banks. That will hit the
weakest banks hardest, while giving lenders with the highest
ratings, such as HSBC and JPMorgan, a competitive advantage in
securing funding, the analyst said.

Banks in southern Europe may be unable to fund themselves
privately at all. More than 800 lenders borrowed from the ECB in
December and February to cover maturing debt and boost liquidity
buffers. After a flurry of senior unsecured bond sales in
January and February, the market froze again with Lloyds Banking
Group Plc, 40 percent owned by the government, being the only
publicly traded lender to sell unsecured bonds in April.

‘Limited Appetite’

Under pressure from regulators, banks are already shifting
to longer-term, more stable and more expensive sources of
funding, eroding profit. RBS cut its reliance on commercial
paper and certificates of deposit by more than half to 22
billion pounds ($35.6 billion) at the end of 2011, the Citigroup
note said.

“The big question is how will banks fund themselves going
forward at a rate that is in keeping with providing credit to
the economy,” said Guy Mandy, a fixed-income analyst at Nomura
Holdings Inc. in London. “At this stage there is very limited
appetite for private funding into banks.”

Downgrades would also trigger margin calls and force
lenders to post additional collateral to counterparties at a
time when balance sheets are encumbered to record levels.

Morgan Stanley would need to post an additional $9.61
billion were it to suffer the maximum three-step downgrade, as
well as a two-level reduction by S&P, the New York-based lender
said in a filing last week. Citigroup would require $4.7 billion
if cut by two steps, it said.

BlackRock Mandates

BlackRock Inc., the world’s biggest asset manager, said on
April 18 it may be forced to reduce business with some banks if
their ratings are lowered to comply with clients’ mandates.

“Many banks will have agreements in place that say if your
ratings drop you need to post more collateral because you are
deemed to be a higher risk,” said Nomura’s Mandy. “The general
squeeze of collateral, whether it is from downgrades, assets
pledged to the ECB or the general trend toward collateralizing
everything, is likely keeping pressure on banks.”

The more a bank’s balance sheet is pledged as collateral,
the further unsecured creditors are pushed down the queue for
repayment. The process is accelerated by the increasing use of
ECB funding and covered bonds.

Improved Conditions

Moody’s may stop short of imposing the steepest downgrades
following better-than-estimated first-quarter earnings and
evidence of rising capital and liquidity buffers. JPMorgan,
Goldman Sachs, Deutsche Bank, RBS and BNP Paribas were among
banks that beat analysts’ estimates in the first quarter after a
resurgence in trading income.

Conditions in the interbank markets have also improved
since the ECB announced its plan to offer banks unlimited three-year loans on Dec. 8. The Euribor-OIS spread, a measure of
banks’ reluctance to lend to one another based on the difference
between the borrowing benchmark and overnight indexed swaps, is
at 0.38 percent, a nine-month low.

Moody’s had planned to start publishing details of any
downgrades in April. On April 13, it issued a statement saying
it was delaying publication until early May, a move some are
taking to suggest banks’ lobbying efforts may be paying off.

“It’s important to note that when Moody’s first came out
to render an opinion” it was before the stress-test results and
the first-quarter earnings of the large institutions, Morgan
Stanley Chief Executive Officer James Gorman, 53, said on an
April 19 call to discuss the bank’s results for the first three
months. “It’s important and constructive to note they’re
delaying their readout on this.”